Gone to Cash…

The equity markets have been more turbulent of late.  As I type, most markets outside the U.S. are around 20% off their highs and the U.S. markets are in a ~10% drawdown.  Today, the NASDAQ is off more than 3%, apparently based on earnings reports from Amazon and Alphabet which were not well received.  I am dropping a quick note during this market turbulence to update on a “tactical” move I made in one of my accounts.  I went to cash…

So, on October 10, 2018, I went to cash in one of my accounts.  Specifically, I reallocated the U.S. stock exposure in the account to a guaranteed return/cash equivalent type account.  So about 70% of the account went to cash and the 30% allocation to foreign stocks remains long.

This account represents only  about 15% of my securities/investments.  I am experimenting in the account with a tactical strategy.  The strategy essentially is 100% long stocks unless they are expensive and have negative momentum.

I am using the CAPE as the primary determinant of expensive, but it must be cross verified by some other indicators like Tobin’s Q, dividend yield, and P/S.  I also use a simple moving average indicator for the momentum/downtrend signal.

Essentially, the “strategy” is similar to the ETFs VMOT (offered by Alpha Architect) and VAMO (from Cambria Funds).  This main differences are that I am trying to bias the strategy to be more long by not going half out of stocks if only one of the two signals is triggered (i.e., if stocks are expensive but trending, I am long).

Basically, I am using valuation as a prerequisite (if >then) rule for the trend following/risk management rule.  I am also using the inverse on the decision to re-enter (if trend post > then, apply value).  So a market that is no longer expensive (for example during a bear sell off) only gets bought once the trend turns.

I am also using cap-weighted indexes rather than value or momentum factor equity baskets.  There are a couple of other tweaks around sort of turning the trend following on and off, which I might share if it turns out to be incredibly material or something (doubt it).

I really don’t think anyone can “dance in and out of the market” based on their intuition or the market narratives they develop.  I think you have to outsource these kind of decisions (especially at emotional times of market volatility) to a system/algo.  When equities are expensive and have negative momentum it is definitely not a target rich environment, historically.

Check out this post by Jake of EconomPic on the historical data.  There are also tons of discussions about this on the Meb Faber and Alpha Architect sites.

I think the moves took until market close on 10/10 to get implemented (this is in a tax advantaged, transaction free account).  The total market index (“VTI”) is a good proxy  for the portion I moved (I will discuss the other allocation as well).

It looks like VTI closed at 142.57 on 10/10.  As I type (10/26/18), it is at 135.31.  So, I dodged about a 5% drawdown, so far.  However, I still have 30% allocated to the world ex-U.S. index (“VXUS” proxy).  VXUS closed at $50.90 on 10/10 and is quoted at $48.13 as I type.  This is also in a little bit over a 5% drawdown.  So I suppose the net benefit of my Soros-like prescience, to date, is about a 3.5% drawdown avoided (versus a 100% long equity position).

I have not had the pain of a ton of whipsaws with this strategy yet, but I’ve only been tinkering with it for maybe a year or two.  In the interest of not fomenting a bunch of bad behavior amongst my readers (though I think most of you are likely to be very sophisticated), I do not have a large portion of my (meager) assets allocated to this and I am very skeptical of my ability to beat buy and hold (most of the research on the site mentioned above show that the trend systems slightly underperform but with less volatility).

I will almost certainly experience painful whipsaws often in the future in this account.  I suppose the ultimate measuring stick will be if I value the avoided drawdowns more than I feel the pain of the whipsaws.  That will probably depend on whether I am able to mentally frame the two as gains or losses.

I hope that you weather the volatility in the markets well.  As someone who plans to invest much more in equities in the future and desires larger future expected returns, I would welcome a large drawdown.


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